Yahoo Finance Declining Stock and Decent Financials: Is The Market Wrong About CTS Corporation (NYSE:CTS)?
CTS (NYSE:CTS) has had a rough three months with its share price down 10%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study CTS' ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for CTS
How To Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for CTS is:
11% = US$54m ÷ US$491m (Based on the trailing twelve months to September 2022).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.11 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
CTS' Earnings Growth And 11% ROE
At first glance, CTS seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 14%. However, while CTS has a pretty respectable ROE, its five year net income decline rate was 22% . Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
That being said, we compared CTS' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 18% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about CTS''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is CTS Making Efficient Use Of Its Profits?
CTS' low three-year median payout ratio of 12% (implying that it retains the remaining 88% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.
Additionally, CTS has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
Summary
On the whole, we do feel that CTS has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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